Citi is bracing to miss a profit target

Bank may not meet its 2015 goal for return on tangible common equity

ChristinaRexrode

JulieSteinberg

Citigroup Inc. is warning investors it may miss a key profitability target after the Federal Reserve rejected the bank’s capital plan last month, people familiar with the matter say.

The Fed on March 26 shot down the New York bank’s proposal to boost its dividend and ramp up stock buybacks, saying it had failed to measure potential risks to its operations during a severe economic recession.

The rejection makes it unlikely Citigroup can hit its 2015 goal for return on tangible common equity.

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The measure—a ratio of profit to equity owned by shareholders—isn’t a headline number like earnings per share. But investors use it to measure banks against one another when comparing profitability.

The figure also is important for Citigroup Chief Executive Michael Corbat, who promised investors he would ramp up profitability significantly when he took over the bank less than two years ago.

The bank potentially missing the target “disappoints me,” said Anton Schutz, president of Mendon Capital Advisors, a Rochester, N.Y., firm with $201 million in assets under management that owns Citigroup stock. “When you decide to change the CEO of a company, and one of the goals is to improve the relationship with regulators and it doesn’t happen, that’s disappointing.”

Citigroup’s stock has fallen more than 7% since the capital-plan rejection, suggesting some investors are losing faith.

Since the Fed’s decision, Citigroup’s investor-relations department has talked with shareholders to lower expectations. The bank’s overtures to investors show how, more than five years after the financial crisis, the Fed’s decisions continue to loom large over financial institutions and their shareholders.

Citigroup on Monday also agreed to pay $1.12 billion to investors to settle claims stemming from mortgage securities sold before the financial crisis, suggesting the bank is trying to put its legal woes behind it and focus on profitability and other matters.

In March 2013, less than five months after becoming CEO, Mr. Corbat told investors the bank planned to boost its return on tangible common equity to 10% or higher by 2015, after stripping out the effects of one-time gains and losses. The following week, the bank earned praise for getting permission from the Fed to buy back more shares. At the time, the bank’s adjusted return on tangible common equity was 7.9%. Last year, it rose to 8.2%.

The Fed’s latest decision means the third-largest U.S. bank by assets isn’t able to boost the capital it had planned to return to shareholders, which will affect the return on tangible common equity. If more capital were returned to shareholders, the return-on-common-equity percentage would rise.

The bank still could meet the target if it improved overall profit. But Citigroup investors likely will have to wait at least until 2015 to see an increase in dividends or stock buybacks, people familiar with the bank have said.

In public, Citigroup hasn’t backed away from its profitability goals, but investors and analysts said the bank was counting on its ability to undertake a large share repurchase to meet the 2015 target. Even before the “stress test” results were released last month, the bank appeared to be losing some swagger about the goals it set in 2013.

On March 3, Chief Financial Officer John Gerspach noted at a conference that the bank would “clearly” have to increase the amount of capital it returned to shareholders, “subject to regulatory approval,” to meet the goal.

Michael Mayo, an analyst at brokerage firm CLSA, has revised his estimates for Citigroup’s 2015 return on tangible common equity. Before the stress tests, he had projected Citigroup meeting the target of 10%. Now, he believes the bank will miss it at 9%.

Still, Citigroup, during calls to investors, has reaffirmed its belief that it will make certain other targets, such as its return on assets and its efficiency ratios. Return on assets is a measure of profit a bank generates in relation to the assets it holds. The efficiency ratio looks at how effectively a bank measures costs compared with its revenue.

Bloomberg

The bank in its March 2013 presentation said it was aiming for a mid-50% efficiency ratio for the part of the bank that doesn’t include Citi Holdings, the money-losing unit where the firm keeps “bad bank” assets it wants to sell. It is aiming for a return on assets of between 0.9% and 1.1%. Mr. Mayo said he believes Citigroup can meet those measures.

The bank said it would be sharply focused on achieving those targets in light of its possible failure to meet the return-on-tangible-common-equity target, said one portfolio manager at a hedge fund who has been in touch with Citigroup’s investor-relations team.

One bank employee put extra emphasis on Citigroup’s commitment to deliver on the other targets, this person said.

Separately, Citigroup’s settlement on Monday—with an investor group that previously reached a similar $8.5 billion settlement with Bank of America Corp. and a $4.5 billion deal with J.P. Morgan Chase & Co.—will require Citigroup to take a $100 million charge in the first quarter of 2014. It reports earnings next week.

Nevertheless, Mr. Schutz, the investor, is still optimistic about the bank and expects it to eventually receive permission to return more capital. “As long as they show us a path to getting there, that satisfies me as an investor,” he said.

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